The solution to inflation: View inflation as a lack of supply problem, not an excessive demand problem

Background

Inflation is a general, progressive elevation in the prices of services and goods within the economy.

It is not an increase in one price or a dozen prices. It is a general increase in prices. And it is not a momentary price change; it is a progressive change taking place over months and years.

The U.S. government is Monetarily Sovereign. It has the unlimited ability to create U.S. dollars.

The Federal Reserve views inflation as an “excessive demand” problem, raising interest rates to combat it. The Fed’s theory is:

–Higher interest rates make borrowing more expensive for consumers and businesses. This tends to reduce spending on big-ticket items like houses and cars and can lead to decreased business investment.

–As interest rates rise, saving becomes more attractive. People may save more rather than spend, reducing overall economic demand.

–Higher interest rates reduce the overall demand for goods and services by curbing spending and borrowing. With lower demand, prices will stabilize or decrease, helping control inflation.

–The Fed aims to bring demand in line with supply by slowing down economic activity. This helps prevent the economy from overheating and keeps prices from rising too quickly.

–Higher interest rates can also influence inflation expectations. If businesses and consumers expect inflation to be controlled, it can become a self-fulfilling prophecy, helping stabilize prices.

Unfortunately, bringing down demand is recessionary. Also, when interest rates rise, businesses’ borrowing costs increase. This includes loans for expansion, equipment, and operational expenses.

Businesses facing higher borrowing costs may raise prices to maintain profit margins, potentially leading to higher consumer prices.

Historically, however, inflation has not been an excessive demand problem but a lack of supply problem.

Rule #1. A price or prices can rise progressively only if there is a scarcity of crucial products or services- notably oil, food, and labor.

Prices cannot increase when products and services are plentiful.

Price increases would be temporary without scarcity as plentiful supply would naturally reduce prices.

For instance, it is believed that inflation can be caused by:

Expectations: If consumers or businesses expect prices to rise, they may temporarily increase their purchases or adjust their pricing.

However, without underlying scarcity, the market will self-correct.

Currency Devaluation: Devaluation can increase import costs, resulting in higher prices for imported goods.

However, if these goods are plentiful globally and alternative sources exist, the price increases may be reversed.

Devaluation is intended to boost exports, thereby injecting money into the economy. Contrarily, the supporters of devaluation often criticize government deficit spending for the same reason, as it also increases the money supply.

Increased Demand: Increasing demand typically indicates a healthy economy. If supply can match demand, prices will stabilize.

However, when supply falls short of demand, shortages lead to prolonged price increases.

Inflation occurs due to scarcity. Whether it involves oil, food, labor, or other essential inputs, this scarcity increases prices.

When there is no underlying scarcity, price increases due to expectations, devaluation, or demand growth will be temporary and self-correcting.

Rule #2. There is no “excessive demand”; instead, there is “inadequate supply.” Inflation always is supply-based, never demand-based.

Increased demand is an essential requirement for economic growth that should be encouraged rather than suppressed.

This perspective alters the understanding of demand-pull and cost-push inflation typically taught in economics classes.

Demand-pull inflation supposedly occurs when demand for goods and services exceeds supply, leading to higher prices. This should be viewed as inadequate supply, i.e., shortages, and cured by addressing the scarcity of goods and services, not the demand.

Cost-push inflation has been said to occur when rising production costs (e.g., wages and raw materials) lead businesses to increase prices, resulting in inflation. Production costs rise only when shortages, e.g., labor shortages push up wages, and raw material shortages push up purchase costs.

This inflation should be cured by addressing the shortages of labor and raw materials.

Rule #3. Recession is not an effective cure for inflation. Both recession and inflation can exist simultaneously (i.e., “stagflation”).

The two frequently attempted solutions for inflation—reducing federal spending and raising interest rates—are detrimental to growth and can lead to recession.

Reducing federal spending can worsen inflation by creating raw materials and labor shortages. Raising interest rates may also increase inflation by elevating business and consumer costs.

Rule # 4. To prevent/cure problems, cure the cause(s). Because inflation should be viewed as a supply problem, not a demand problem, curing supply constraints is the preferred approach to managing inflation.

This includes increased government investment in infrastructure, shipping, basic materials, innovation (R&D), and workforce development through education and training.

Encouraging demand and ensuring supply keeps pace supports sustainable economic growth and helps combat inflation without leading to a recession.

Summary: To prevent and cure inflation:

1. Government policies should prioritize increasing supply through strategic investments rather than relying on monetary policy to reduce demand. Increasing demand is essential for economic growth.
2. When inflation is related to oil shortages, the government should fund increased oil exploration, drilling, refining, and delivery, as well as increased funding for renewable energy creation and distribution.
3. When inflation is related to food costs, the government should fund aid to farming, farm education, farm equipment, storage, and shipping.
4. When inflation is related to increased labor costs, the government should fund education and training. It should also reduce labor costs by eliminating FICA and reducing business taxes.
5. Other inflation-causing shortages should be addressed via federal support
6. Discontinue efforts to reduce federal spending, the deficit, and the debt. So-called “excessive” federal spending does not cause inflation, and it can be part of the cure.
7. Stop raising interest rates as a cure for inflation. Low rates do not cause inflation, and high rates increase the cost of goods and services—exactly the opposite approach to inflation prevention and cure.

A Monetarily Sovereign government should view inflation as a lack of supply problem, not an excessive demand problem, to prevent and cure inflation without a recession.

Cure the supply problem, and you cure inflation without a recession.

Rodger Malcolm Mitchell

Monetary Sovereignty

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